Based on the continuously declining margins, we reiterate our long-term Underperform recommendation on the manufacturer of diversified engineered products and components, Leggett & Platt Incorporated (LEG), with a target price of $20.
The company recently posted earnings of 22 cents per share for fourth-quarter 2011, which came in ahead of both the Zacks Consensus Estimate and year-ago quarter’s earnings of 21 cents. However, we believe it to be an inorganic growth, which was primarily spurred by the company’s share buyback program.
Gross margin, for the quarter, contracted 90 basis points to 16.7% due to higher input costs, while operating margin shrunk 470 basis points to 1.5% due to a 10% rise in selling and administrative expenses.
Leggett’s operating performance is heavily dependent on the price of raw materials, particularly steel. Global steel markets are cyclical in nature and the commodity has witnessed extreme volatility in the recent years, leading to significant swings in pricing and margins for the company.
Moreover, higher raw material prices have prompted some of Leggett’s customers to prefer lower cost components over higher cost ones, thereby adversely affecting margins. We believe, a continuation of this trend is likely to affect the company’s operating performance moving ahead.
Further, Leggett’s significant international presence exposes it to unfavorable foreign currency translations. However, doing business in foreign countries may have a substantial effect on Leggett’s operations and financial performance, as almost 25% of the company’s revenues are generated from its international operations.
Above all, Leggett operates in a highly competitive industry, and thus may find it difficult to execute and implement new business strategies, which in turn, will impact its operations adversely. The company faces intense competition from its rivals, such as Flexsteel Industries Inc. (FLXS) and Genuine Parts Company (GPC). Furthermore, Leggett & Platt also face competition from local and regional players.
Our recommendation on the stock is supported by a Zacks #4 Rank, which implies a short-term Sell rating.
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